Oil Price Spike Highlights Aftermarket Pressures

New instabilities in the Middle East triggered events that reveal immediate pressures on the aviation aftermarket. On Jan. 31, oil prices hit $100 per barrel for the first time since 2008, soaring on word of protests in Cairo’s Tahrir Square. This sharp increase sent international jet fuel prices up to more than $115 per barrel, with those in the Northwest Europe market peaking at just over $120 per barrel (see chart, p. 46). When fuel prices belled two years ago, airline cost-cutting behaviors put new stresses on aircraft maintenance providers. Among airlines—even the Middle East’s service-oriented, ultra-long-haul carriers—that close-to-core mentality stuck.

The recent spike in oil prices highlights “continuing challenges” faced by the aviation industry and presents evidence of recessionary pressures “still being experienced,” Iain Lachlan, divisional senior vice president of aircraft maintenance for Emirates, said in his opening remarks at Aviation Week’s MRO Middle East conference here Feb. 1.

Over the last three years, the global economic downturn has accelerated trends taking root at airlines to focus on the primary business of transporting passengers. Inventory destocking, outsourcing and cutting costs (including labor) take priority, even as airlines order new aircraft to stay fresh and competitive in their markets. For maintenance and engineering departments and MRO providers, this means supporting more component work, facing increased competition for contracts and developing new ways to package services.

A surge in fuel costs gives these issues new urgency. Conversations springing from the fuel uptick at the end of January highlight just how pervasive and crucial lean outsourcing strategies have become for operators. In response, airline engineering and maintenance departments and MRO providers here in the Middle East, where investment activity remains vibrant, continue to develop their services with these pressures in mind.

An often-cited figure here is 18.3%—the passenger traffic growth rate the International Air Transport Association (IATA) pegs to the Middle East, compared to the global rate of 10%. Companies based here such as Emirates and Mubadala Aerospace, and those heavily invested here such as Goodrich Corp. and Lufthansa Technik, are quick to point out how the region’s growth nearly doubles the average rate for the rest of the world.

Growth in the regions surrounding the United Arab Emirates bolsters its market position. TeamSAI’s Chris Doan calls this part of the world “the growth engine of the future.” He notes that while profits have been “pretty elusive” for aftermarket companies so far, “a lot of positive developments [have taken place] here, recognizing the growth that will exist.”

In the next 10 years, the total aftermarket spend base in the region (including military and business aviation work as well as civil helicopter and air transport) is expected to grow substantially, with 5.3% annual increases driving the total to $11.2 billion in 2019 from $7 billion in 2010, according to AeroStrategy figures.

Based on this growth pattern, MROs and airline maintenance organizations continue to add capabilities based on rising demand. The volume of work is here, but much of it is divided among existing stakeholders. Lufthansa Technik’s Walter Heerdt, senior vice president of marketing and sales, explains his company’s strategy as sizing the accessible market. “The accessible market is here,” he says, “but it is not as big as you might think.” For that reason, partnerships with existing players and OEMs mainly drive developments.

Emirates’ Lachlan stresses the same strategy: Opportunities in the aviation aftermarket are plentiful in the Middle East, he says, “but these can only exist through partnerships.”

Lufthansa Technik, for one, is in the middle of solidifying such an arrangement with Oman Air, stemming from a 2009 strategic partnership. The agreement would see a new hangar erected at Muscat International Airport for base maintenance up to C checks on as many as two widebody and two narrowbody aircraft simultaneously. Heerdt says his company and Oman Air have not made a final decision yet, though he is “very confident that [it] is doable.”

Mubadala Aerospace also is working its partnership via subsidiary Abu Dhabi Aircraft Technologies (ADAT) with General Electric and the Engine Alliance on GE90, GEnx and GP7200 engine maintenance. This will bring the first network overhaul provider approved by the OEM to the region. Groundbreaking for this facility in Abu Dhabi is planned for the first quarter of this year, and operational launch for early 2013. Abdulla Shadid, senior business development manager for Mubadala Aerospace, calls the project “a natural win-win, with so many GE engines flying in the region.”

The Mubadala-GE-Engine Alliance venture is an example of what David Stewart, principal at AeroStrategy Management Consulting, identifies as today’s movement toward an “OEM-centric supply chain.” In identifying trends driving MRO, Stewart emphasizes that companies “need new relationships” with manufacturers and suppliers—especially independent MRO providers that want access to new programs.

In addition to collaboration with industry partners, OEMs and MRO organizations in the Middle East continue to stress a focus on fleet performance. This marks a new direction for many MROs, as Uwe Jakob, vice president of planning and technical services for ADAT, points out. “If you are honest, [fleet performance] was not the driving focus for MROs in the past,” he says. Today, downtime sways contracts.

To that end, ADAT is developing a fleet monitoring office tied to its engineering department, for which it plans to break ground in July. Like other real-time OEM and MRO offerings, such as GE’s myEngines software suite and the customer response center Hamilton Sundstrand opened in November 2010, the ADAT office would aim to give customers a constant, mobile view of service work occurring on their aircraft or engines.

Goodrich’s Jebel Ali campus, which does work for the major UAE flag carriers, Oman Air and Saudi Arabian Airlines, among others, also names its short-term goal as “[working] very closely with each operator, to help them to match their requirements,” says Joel Haldemann, Goodrich vice president of MRO for Europe, the Middle East and Africa. Speaking to the Dubai campus’s pool of customers, Haldemann says about half send work to Goodrich under total support arrangements.

Customer service counts, since occasionally it can undermine cost, notes Pierre Reveille, vice president of Airbus Services Solution, who manages the aircraft maker’s contracts with its MRO network. “Sometimes we do go for a higher price, taking into account quality,” says Reveille, though he notes that the margin would never be more than 5-10% higher.

As airline customers demand more comprehensive solutions at a competitive cost, they also demonstrate a need for new services from third-party suppliers. Component maintenance is a traditional MRO revenue base that continues to see growth, particularly for new types of value-added service agreements.

Lufthansa Technik’s Walter Heerdt says his company sees a growing customer base for component repair and logistics globally. “Worldwide, as this is not only true for here in the Middle East, we see that there is a demand for cooperating with us [on component management logistics],” he says. Lufthansa Technik has more than 2,100 aircraft under component support arrangements.

Component repair management, especially for larger rotables such as landing gear, forms a big part of the growth plan of Pakistan International Airlines Engineering. The entity, which recently was rebranded as PK MRO, hopes to break ground by the end of March on a new landing gear facility, says Deputy Managing Director Sam Sayani. Right now, PK MRO is the only facility in the region that can work on Airbus A300B4 landing gears; it also overhauls them for Boeing 737s and Airbus A310s. Plans call for adding in-house capability on Boeing 777 auxiliary power units, Sayani says.

Component financing programs cater to many of the same airline pain points but also provide liquidity. Mubadala Aerospace has launched subsidiary Sanad Aero Solutions to capture its share of that market. “Component rotables—this is what has been challenging for airlines,” says Shadid.

Sanad sees a market for another $10 billion in spare components and engines in the next decade, says CEO Troy Lambeth. Current rotable and spare engines holdings equal about $34 billion, based on AeroStrategy projections. The in-service fleet equals more than 22,000 aircraft. That is a simple average of slightly more than $1.5 million in spare components and engines per aircraft, Lambeth says.

In terms of aircraft, the next decade will see about 12,000 deliveries, based on current orders, and the projected retirement of 6,000 aircraft for a net increase of about 6,000 aircraft. Sanad uses a more conservative estimate of 5,000 aircraft to assume a $7.5-9 billion addition to the value of required spares, using today’s $1.5 million requirements-per-aircraft figure. Taking into account newer technologies, more widebody deliveries, new spares requirements and new-generation engines, Lambeth thinks another $10 billion is a conservative estimate.

Aircraft appearance work placement also serves as a market indicator. For example, Emirates, which eventually will have a fleet of 90 Airbus A380s in addition to its A330s, A340-300s and Boeing 777s, recently invested in a huge new paint facility, says Lachlan. Last year, Emirates commissioned the building, which closely resembles Airbus’s own facility, and it is installing six aerial-mounted platforms of its wing-docking system. This investment came alongside design changes Emirates made to its airframe maintenance facilities to accommodate the new type.

Like Emirates, Qatar has plans to grow its A380 fleet. “We’re a hungry beast that just can’t wait for these new aircraft to arrive,” says Tony Hughes, Emirates senior vice president for the Americas. Hughes says Qatar CEO Akbar Al Baker has indicated he plans to add more A380s to the five on order.

While new deliveries fuel growth, so does lease hand-back activity. According to M. Yassine Sabbagh, executive director of Mideast Aircraft Services Co. (Masco) in Beirut, work for lessors has made up the majority of Masco’s revenue in the last two years. In 2010, he says 70% of work was painting and performing C checks and bridging checks for lessors such as International Lease Finance Corp. Sabbagh adds that, like TeamSAI’s Doan, he sees growth in technical services or consulting work. Masco provides airlines with assistance in acquisition consulting and aircraft customization from the assembly line through delivery and lease handback, Sabbagh says.

The frequent changing of hands in the leased aircraft market foreshadows another trend—greater numbers of aircraft being parted out. Record numbers of aircraft were parked and parted out in 2008 and 2009 An estimated 15-20 aircraft are being parted out each month now, says AeroStrategy’s Stewart.

In addition to price pressures, these reintroduced, airworthy parts muffle the need to restock inventories with new parts: The global MRO market should be seeing the “kick back” of airline inventory restocking in 2011 and 2012, Stewart points out, but it is being “buffered by the surplus [resulting from] parting out.”

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